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How to Cash In on the Best Stocks in Pharmacy Benefit Management

Meet the stocks that are saving healthcare billions and could return some of that stash to your pocket.

Even if you're unfamiliar with the term pharmacy benefit manager, or PBM, you're almost certainly a customer of one. In healthcare, PBMs are the Wizards of Oz, the Wunderkind maestro concealed behind the curtain. As drug prices skyrocket, the companies promise big savings on drug costs to insurers and employers.

PBMs will be delivering on that promise to the tune of $2 trillion according to a report by healthcare consulting firm Visante. That's how much these wizards are expected to cut from prescription drug expenses between 2012 and 2021 for their customers, be they big employers, Medicare, or consumers.

As you can imagine, all that cost-cutting means big profits for investors. And the future looks even brighter for their shareholders, because squeezing costs out of the healthcare system puts PBMs in the sweet spot of Obamacare. An additional nice bump could be coming from a forecasted double-digit spike in drug spending, as Bruce Japsen pointed out recently. (If you haven't seen his helpful story, click here to read it. I'll wait.)

Now, without more ado, let's dive straight into the best of the bunch.

CVS Health Corp:Buckle up for blockbuster growth CVS ((NYSE:CVS) is the second-largest PBM in the U.S. The company has been doing a fantastic job at delivering attractive shareholder returns through earnings growth, dividend increases, and share repurchases. The rewards should just get bigger, as CVS plans to return $7 billion in cash to shareholders in 2015 in repurchases and dividends, a 30% year-over-year increase.

A big plus for CVS over other PBMs is the company's multi-pronged revenue stream. CVS is well known as a drugstore giant, and it recently stepped up its retail presence by acquiring Target's pharmacy business. The purchase should increase CVS' annual sales by $4 billion.

CVS also has a mail order business and a walk-in healthcare clinic (Minute Clinic) -- a neat little business that takes advantage of the millions of newly insured Obamacare customers.

While the PBM segment of CVS has been seeing stronger revenue growth, retail contributes a lot more to gross profit. Last quarter, CVS Health's PBM segment net revenue increased 18.2% to $23.9 billion, while revenue from its retail pharmacy improved 2.9% to $17.0 billion, year-over-year. The PBM side of the business saw $1 billion in gross profit last quarter, while retail contributed $5.3 billion.

Looking ahead, here's what really gets me excited about CVS: The company recently made an acquisition that could seriously pad its PBM balance sheet.

In May, CVS spent $12.7 billion to buy Omnicare, the largest provider of prescription drugs to senior-care facilities. The number of people 65 or older should reach 72.1 million by 2030, more than twice their population in 2000. Clearly, the purchase will expand CVS' pharmaceutical sales to a fast-growing market.

While that's no small benefit, it's in the PBM business that CVS should really score. The purchase gives CVS more purchasing power to negotiate discounts from drug manufacturers. In particular, it should help CVS get better discounts on expensive specialty drugs, whose sky-high pricing is pounding consumers, insurers, and employers alike.

CVS' first-quarter net revenue rose 11.1%, beating expectations. Looking ahead, the company doesn't expect to miss a beat. Management moved up the low-end of its guidance for earnings last quarter. The company now expects earnings between $5.08 and $5.19 per share, compared to its previous low-end guidance of $5.05.

Express Scripts: Merger madness could make it volatile short termThe healthcare sector's favorite game, merger madness, has thrown a joker into the deck of cards for Express Scripts (NYSE: ESRX), the nation's largest PBM. While I like Express Scripts and own the stock, I'm pushing the pause button on accumulating more until the game ends.

Here's why: Big insurer Anthem is currently pursuing Cigna. Because Anthem currently contracts with Express Scripts, if Anthem buys Cigna, it could bring Cigna's additional PBM customers to Express Scripts.

Sounds great, right? But hold on. The additional scale means that Anthem could press hard for big price concessions from Express Scripts. That could lead to a repricing on the next contract, which could lead to a negative EPS revision, despite the addition of business.

On the other hand, Anthem could also emerge as a potential bidder for Humana, which is reportedly up for sale. An Anthem/Humana deal could also be bad news for Express Scripts. If Anthem pulled Humana's PBM business in-house, it could provide Anthem with the necessary infrastructure to dispense with Express Scripts altogether. While I don't think such a nuclear option is too likely, the added leverage of Humana gives Anthem a big club to wield to get a more favorable contract from Express Scripts.

It's impossible to know how any of this will shake out right now. In addition, there's a positive side. If Express Scripts ends up with many more customers, that will solidify its position as the market leader in the PBM industry. With so many moving cogs, there's even a chance Express Scripts could even net a big win. Assuming the company doesn't give up much in its next contract with Anthem, it could use the added clout of more clients to notch bigger price concessions on specialty drugs.

Last year, the company successfully negotiated a discount in hepatitis C drugs from AbbVie by excluding competitor drugs from its national formulary. Express Script's CEO George Paz has made it clear his next target is cancer drug pricing, and potentially the new cholesterol-lowering PCSK9 drugs.

Express Scripts' position as the nation's biggest PBM gives it unequaled clout over drug suppliers. With specialty drug spending on the rise, it seems likely payers will turn to the PBM who can get them the most advantageous drug pricing to help control their spending. In addition, Express Scripts' huge claims volume (1.3 billion claims processed in 2014) allows it to scale its own costs, and should help it maintain a profitable platform for continued growth.

Bottom lineI like the PBM industry long term, as it's well aligned with the current challenges our country faces in healthcare. Quite simply, these companies not only reduce cost, they sometimes even improve quality of outcomes.

So how could investors build up some additional future cash for themselves in the PBMs? For right now, CVS strikes me as attractive. But for those who like the biggest dog in the game and are willing to ride out some possible near-term volatility, Express Scripts remains a solid play.

Author

Cheryl has six books published, and currently resides in Hawaii with her husband, her daughter and two dozen surfboards. With a 20-year background as a former medical technology and management consultant, as well as a cancer survivor, Cheryl has a unique perspective on health care. Follow her on Twitter at @uthorcdswanson